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Billing Schemes, Part 3: Pay-and-Return Invoicing

Anonymous tips are an important source of information on employee theft.

This is the third article in
a four-part series on identifying false
invoices and their issuers. It explains
the pay-and-return billing scheme, in
which an employee creates an overpayment
to a vendor and pockets the subsequent
refund. The other stories focus on shell
companies (See JofA, Jul.02, page
76 or www.aicpa.org/pubs/jofa/jul2002/wells.htm
), pass-through billing schemes (See
JofA, Aug.02, page 72 or www.aicpa.org/pubs/jofa/aug2002/wells.htm
) and personal purchase schemes, which
will be the subject of “The Fraud Beat” in
October.

philosopher once said the road to
hell is paved with good intentions. As all fraud
examiners know, given the right circumstances—for
example, a personal financial crisis coupled with
weak internal controls on the job—many otherwise
law-abiding employees will rationalize their way
into stealing from the companies they work for.

The following case study illustrates such a
situation and shows how CPAs can protect their
clients and employers from pay-and-return billing
scams. This particular ruse shouldn’t have lasted
as long as it did; a simple, inexpensive service
could’ve stopped it much earlier.

NO WAY OUT
As Veronica, an
accounting clerk at a dental supply wholesaler,
hung up the phone, her cheeks reddened with anger
and embarrassment. She knew her coworkers at the
dozen or so desks nearby had heard everything—as
usual. This call had been from yet another of her
husband’s many frustrated creditors, who demanded
money she didn’t have. The outstanding debts arose
from a business that was operated strictly by her
spouse, not her. But as Veronica knew so well, in
the community property state where she and Les
lived, his debts were her debts,
too.

When Veronica married Les eight years
ago, he had been a fast-talking hustler. But
success had eluded him; one after another his
business ventures failed. Then, three years ago,
to get a fresh start, the couple filed for
personal bankruptcy. Yet, somehow, they again had
gotten over their heads in debt. This time,
though, because you can declare bankruptcy only
once every seven years, they became desperate.

AN APPARENT IMPROVEMENT
In the office,
Veronica’s colleague, Jenny, had tried not to
eavesdrop. But the low partition between their
cubicles ensured she would hear most, if not all,
of the calls Veronica received from creditors.
Since Jenny knew her friend was in trouble, she
wasn’t surprised when Veronica time and again
shared her tale of financial woe. But as the
months passed, Veronica simply stopped talking
about her debts.

A DIFFICULT CHOICE
More than a year
later, Jenny accidentally discovered why Veronica
was silent on the subject. At the end of one
workday, when no one else was around, Jenny
clearly saw Veronica slip a vendor check into her
purse. Now it began to make sense: Veronica was
stealing from the company. Jenny was incensed and
couldn’t think of anything else for several days.
Still, the thought of turning in Veronica made her
ill. But after being with the company nearly 10
years, Jenny had a personal stake in it. However,
she reasoned, if Veronica kept stealing, it would
only worsen her problems, so Jenny decided to
report her friend anonymously. First she thought
of phoning her boss but realized he’d recognize
her voice. Then it hit her: She would call the
company’s CPA firm; they surely would want to know
about this, and they wouldn’t know who she was.

Calling from a pay phone, Jenny
was questioned by a manager at the firm.

“How do you know she’s stealing?” he demanded.

“Because I saw her,” Jenny replied
defensively.

“And who are you?” the
manager wanted to know.

The conversation
ended when Jenny refused to identify herself.

The manager said: “You tell me you witnessed a
theft, but you won’t say who you are. You could be
anybody. I can’t take this further unless I have
more evidence.”

Jenny refused to say
anything more and hung up.

Jenny never
confronted Veronica with what she knew, but she
wanted no more to do with her. Although Jenny saw
Veronica steal another check about six months
later, she clenched her teeth and kept her mouth
shut. That is until several weeks later when
Claude, a CPA recently hired as the company’s
internal auditor, invited her into his office.

ON THE TRAIL TO DISCOVERY
With records in his
cubbyhole office already piled high around him,
Claude explained to Jenny that—as part of his new
responsibilities—he was meeting with a number of
employees to get their opinions on the company’s
accounting operation.

During his
discussion with Jenny, Claude wanted to focus on
fraud by company employees. So he introduced the
subject by asking her if she had known one of the
company’s purchasing agents took several hundred
thousand dollars in kickbacks to award favorable
manufacturing contracts. Jenny said everyone in
the company had heard the rumor. To avoid
publicity, the company had decided not to
prosecute. It also hired Claude to help prevent
such future incidents.

Finally, he got to
the point. “Has anyone in the company ever asked
you to do something that you thought was illegal
or unethical?” Jenny didn’t have to think long
about that. “No,” she said quickly.

Then
Claude asked, “Do you suspect anyone in the
company is committing fraud?” Jenny sat silently
for a moment. “Should I tell him what I know?” she
wondered.

Looking at Jenny’s face, Claude
didn’t need to hear an answer. He knew something
was wrong and started digging further. Although
Jenny said nothing more, Claude immediately
reviewed Jenny’s job functions and those of the
accounting clerks who worked with her. He found
nothing unusual until he came to Veronica’s job
description, which was disturbing: Her primary
responsibility was processing invoices for
payment, but she also handled the occasional
overpayment received in the mail. This was clearly
a breach of security that needed prompt attention.

Claude’s subsequent investigation revealed
that Veronica was processing certain invoices
twice. When confronted, she seemed relieved and
confessed everything, admitting her favorite
target was her employer’s largest supplier, a
dental appliance manufacturer that printed its
simple invoices in black ink on plain paper. When
strapped for money, Veronica said, she’d make a
copy of the manufacturer’s invoice before stamping
the original. The two were almost
indistinguishable. Then she’d process the first
invoice, send it on for approval, and process the
invoice again a few days later using the copy
she’d made. To further disguise her scheme,
Veronica always put the copied invoice in a stack
of others waiting to be processed for payment.

The company would pay the bill twice. When
the supplier realized the overpayment, it sent a
refund check that landed on Veronica’s desk. She
in turn slipped the extra check into her purse and
later turned it over to Les, who forged her
company’s endorsement with a specially made rubber
stamp and deposited the check in his business
account.

In less than two years, Veronica
had embezzled more than a quarter-million dollars.
True to form, she saved her husband from jail by
claiming the whole scheme was her idea. But
because Veronica was a first-time offender, she
got several years’ probation and served only six
months in a halfway house.

BETTER LATE THAN NEVER
Claude took some
basic steps to prevent such fraud in the future.
First, he instructed the accounting department to
be on the lookout for copies of original invoices.
Poor quality duplicates can be detected with the
naked eye, but some reproductions are good enough
to escape all but the most detailed inspection.
So, as an added safeguard, Claude installed
controls that would warn him if the accounting
department tried to process the same invoice
amount and/or number twice. This required nothing
more than adding an automated procedure to the
invoice payment system. Before printing a check,
the system would scan previous payments to see
whether any were issued for the same bill. If
questionable items turned up, Claude would review
them and determine how to proceed.

Second,
he reassigned the responsibility for depositing
refund checks to a staff member who didn’t deal
with invoices, thus separating critical job
functions and correcting a serious control
deficiency.

Finally, because some of the
most valuable information on suspected employee
crime comes from workers concerned about
reprisals, Claude established a telephone hot line
(see “ What’s So Hot About Hot Lines? ”) so
employees can report suspicions promptly without
fear for their personal safety or job security. He
also recommended that management instruct the CPA
firm to accept and immediately inform the company
of all calls and reports of suspected
fraud.

What’s So Hot
About Hot Lines?
From the search for the
Unabomber to the Enron inquiry,
investigators have found “inside”
information from family members and
coworkers to be especially valuable. One
way to obtain tips from such knowledgeable
sources is to establish telephone “hot
lines” that are convenient and guarantee
callers’ anonymity.

To encourage their
use, hot lines must let callers furnish
information without fear of reprisal.
Since many employees who want to report
misdeeds may be afraid—for fear of
discovery—to call a hot line at work,
such services must be available 24 hours
a day. Although callers report a wide
variety of petty grievances, one simple
fact remains: Some crimes are not
discovered any other way.

There
are three types of hot lines.

Full-time, in-house.
The most expensive and
effective hot lines are staffed—around
the clock—by live personnel who can
answer the caller’s questions and
concerns. Usually only the largest
companies maintain full-time hot lines.

Third-party providers.
Many third parties provide
hot line services that are available at
all times. When an individual calls to
make a report, the provider takes down
the information and relays it to the
client company. Although this type of
service is less expensive than an
in-house version, the employer—not the
service provider—is responsible for
informing employees of its availability
and contact information.

Part-time, in-house.
Many companies have a tip
line answered by company
employees—usually in the internal audit
or security departments—during working
hours. At other times, callers are able
to leave a voice-mail message. Although
inexpensive, this method is not as
effective as the other two types of hot
line because—as explained above—it isn’t
sufficiently confidential and doesn’t
give callers a chance to ask questions
before they give information.

JOSEPH T.
WELLS, CPA, CFE, is founder and chairman of the
Association of Certified Fraud Examiners in
Austin, Texas, and professor of fraud examination
at the University of Texas. Mr. Wells’ article, “
So
That’s Why It's Called a Pyramid Scheme ” (
JofA , Oct.00, page 91), won the Lawler
Award for the best article in the JofA in
2000. His e-mail address is joe@cfenet.com
.

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